Abstract: I study revenue maximizing mechanisms in the presence of agents who are loss averse in the sense of
Köszegi and Rabin (2007). Since the reference point is formed endogenously as an equilibrium object, the principal can influence the agents’ reference points by announcing a particular mechanism.
Two specifications of reference dependence are considered. If the agents narrowly bracket gains and
losses in the good and in the money dimension separately, any optimal mechanism is all pay, and an
optimal auction is an all pay auction with minimum bid; with wide bracketing of gains and losses
over the entire risk neutral pay off, an optimal auction is a first price auction with minimum bid.
Compared to the same environment with risk neutral agents, the minimum bid is always weakly
higher with narrow bracketing and always weakly lower with wide bracketing of gains and losses.
In case loss aversion is very pronounced, differentiability of the value function fails, and no familiar
characterization of incentive compatibility involving the envelope theorem is available. The driving
force behind these results is that agents with reference dependent preferences as in Köszegi and
Rabin (2007) dislike fluctuations in their ex post pay offs. Depending on whether agents bracket
gains and losses narrowly or widely, the principal reduces these fluctuations in the ex post pay offs
in a different manner and extracts the additional surplus.

Abstract: We theoretically and experimentally study independent private value auctions in the presence of
bidders who are loss averse in the sense of Köszegi and Rabin (2007). In one specification, we
consider gains and losses in two dimensions separately, about whether they receive the object or
not, and how much they pay (narrow bracketing of gains and losses); in the other specification, we
consider gains and losses over the entire risk neutral pay off, i.e. the valuation less the bid (wide
bracketing of gains and losses). With wide bracketing, we show that the expected revenue for the
auctioneer is higher in the first price auction than in the all pay auction, and with narrow bracketing,
we show that the opposite is true for the revenue ranking between the first price auction and the
all pay auction. In order to test the theoretical predictions, we conduct laboratory experiments, in
which money and a real object is auctioned in both a first price auction and an all pay auction. In
both settings, the average revenue is significantly higher in the first price auction, suggesting that
bidders may behave according to the one dimensional model, although a real object is auctioned.
Whereas our findings are inconsistent with narrow bracketing of gains and losses, they are consistent
with wide bracketing of gains and losses.

Abstract: Demand is money illusioned if it is not homogeneous of degree 0 in prices and wealth. Welfare is
money illusioned if it is not homogeneous of degree 0 in prices and wealth. The latter definition
allows for a test for money illusion with data, whereas the former does not, since demand may
be set valued.
Static and dynamic versions of this test for money illusion are applied to the
re denomination to the Euro in Germany, using German micro data, and no money illusion is
rejected. The implied welfare loss from switching from the German Mark to the Euro is estimated
between 1% and 10% of the median household income.

Abstract: I study complete and incomplete dynamic financial markets and show that if some agents neglect
inflation, the rational agents who are aware of inflation are driven out of the market in the long
run, in the sense that the inflation ignorant agents consume the economy’s entire endowment. The
reason for this finding is that with inflation, the inflation neglecting agents always (falsely) believe
that the return on their saving is higher than it actually is. Because these agents trade financial
assets in markets with the rational agents, the rational agents end up being borrowers and the
inflation neglecting agents lenders. Since the rational agents’ debt accumulates over time, they
become so indebted that the inflation neglecting agents eventually consume the economy’s entire
endowment.

Abstract: An infinitely lived decision maker randomly receives problems to solve over time. Upon the arrival
of a problem, it is allocated to one of two cognitive systems. The intuitive system makes decisions
fast, subject to an emotional error. The deliberate system always makes the correct decision, but
requires time to complete the thinking process. While thinking, problems continue to arrive, and
the decision maker forgoes option value from being able to think about decisions leading to a
higher pay off until the thinking process is over. This gives rise to a trade off of deliberating versus
intuitive decision making, in the form of endogenously costly contemplation. Besides changing the
quality of the decision, the dynamic environment illuminates that thinking is also instrumental
in the sense that the realization of the decision’s pay off is delayed or accelerated. The model
sheds light on a number of behavioral phenomena such as random choice, inconsistency in choices,
procrastination, and loss aversion, the occurrence of which is the outcome of a perfectly rational
dynamic optimization problem.